Economist Li Wei: How can China's economy continue to pick up?

Some of the long-standing structural problems of China's economy have worsened in the last two years, and as a result, people are not feeling the economy as positive and positive as GDP growth suggests.

Text: Li Wei

2023 has passed, and although there is no official news to confirm it, it should be a sure thing that the year-on-year growth rate of Gross Domestic Product (GDP) in 2023 will exceed 5%.

China is now the world's second largest economy, the largest exporter of goods, and has a significant impact on the global economy.

However, it cannot be ignored that there is a certain "temperature difference" between the excellent performance of the macroeconomy and the microeconomy.

The price level has fallen, the real estate market is sluggish, a considerable number of enterprises are not doing well, some people are having difficulty finding employment, and even some local governments are facing a shortage of funds.

China's economic achievements are undeniable, and the many difficulties we have encountered are also real. Why is this happening?

The author believes that a large part of this is that some long-standing structural problems in China's economy have worsened in the past two years, resulting in the phenomenon that GDP is still growing at a relatively fast rate, but residents' income has not grown at the same time.

If residents' income growth is slow, their spending power will weaken, domestic demand will decline, prices will be sluggish, employment will be weak, and the depth and breadth of economic growth benefiting the people will become very limited.

These are just a few descriptions of the problems that exist in the current economy. In other words, the external symptoms of the disease.

If we really want to solve the problem, we need to explore the cause and give medicine to the cause, so that the medicine can be cured, and what to do is the core problem that the author wants to explain in this article.

01

Solve for overcapacity

Overcapacity is an important term active in China's economic vocabulary, and its meaning is very simple, that is, there is an oversupply of production capacity, which leads to low product prices, related enterprises operating difficulties, and prominent employment contradictions.

Since capacity is oversupplied, there are three ways to deal with it.

First, reducing supply, which we often hear about, means taking measures to reduce output.

Second, increase demand. Assuming that the supply remains unchanged, then the expansion of demand can absorb the excess capacity;

Third, increase demand while reducing supply.

From an economic point of view, overcapacity is a manifestation of the failure of the market to clear. The clearing of the market is the balance between supply and demand, and what is produced is exactly equal to what needs to be consumed.

Moving from overcapacity to supply-demand balance requires a reallocation of resources, and we hope that the result of this allocation will increase productivity, but how do we achieve this?

Let's talk about a topic first, we often say that there is overcapacity in industries such as steel, coal chemical and cement, but no one has ever said that there is overcapacity in the catering industry, why is that?

With restaurants on the streets and fierce competition, it may seem like the most overcapacity industry in China, but it's not. The author believes that one of the biggest reasons for this is that the catering industry is a completely market-oriented industry.

In the market, where each restaurant has a very limited impact on price, it is a perfectly competitive market that is almost ideal. In this market, in order to attract customers, merchants are constantly improving their menus, improving their store decorations, playing various gimmicks to attract customers, setting competitive prices, finding suitable locations to open stores, and so on.

In short, within the scope of the law, in order to make money, do everything necessary. When a restaurant wins the competition, it will be more profitable and will be able to expand its business. When a restaurant loses out of the competition, its business is withdrawn from the market or merged by more competitive merchants. Countless restaurants are established every day, and countless restaurants are closed.

In this process, the survival of the fittest in the catering industry has always maintained a general clearing situation in the dynamics, so naturally there will be no overcapacity problem.

More importantly, with the deepening of market competition, the operating efficiency of the catering industry has been continuously improved, and the service quality has been improved day by day, which has better and better met the dining needs of the people.

There is a phenomenon that I don't know if you have noticed, the industries with excess capacity are often those with a high proportion of state-owned enterprises or the influence of local governments, such as the steel industry.

For the sake of local economic and tax growth, local governments tend to use a variety of resources, such as land and credit, to generate more capacity, rather than adjusting supply and demand according to market conditions.

Since the government's assessment of SOEs is often based on assets and income, SOEs also tend to develop more production capacity rather than focus more on profits. This has two consequences:

First, the old capacity does not go, and the new capacity comes again, resulting in overcapacity;

Second, market competition has no way to play the role of survival of the fittest, and a large number of production capacity and zombie enterprises that should have been cleaned up continue to maintain production, resulting in a large amount of waste of resources and reducing the overall efficiency of the industry.

Both theoretically and practically, including the history of China's modern economic development, have proven that under certain institutional conditions, the market economy is the best system for improving efficiency and creating wealth.

It is precisely because of this that we have declared that China wants to engage in a socialist market economy.

The most critical step to solve the problem of overcapacity is to restrain the behavior of the government and state-owned enterprises, and not let the "visible foot" step on the "invisible hand".

Let the market play the role of allocating resources, then the phenomenon of overcapacity will be greatly alleviated, or even greatly reduced, and the operating efficiency will be greatly improved.

02

Stabilize real estate

As mentioned above, there are three ways to coordinate the problem of overcapacity, and for the supply side, marketization is currently recognized as the best way, but the situation on the demand side is different.

Economic growth is cyclical, and we hope that macroeconomic policies can be used to smooth out these fluctuations and increase the well-being of people.

At present, China's economy as a whole is improving, but some places have been weak, or even very weak, which has caused a very big obstacle to economic operation, and the most typical one in this regard is real estate.

Real estate is one of the most important industries in China today. There is an argument that if many upstream and downstream industries are included, then the real estate sector in a broad sense will account for as much as 30% of China's GDP.

Now there is a large-scale crisis among real estate developers, such as Evergrande Group, which is seriously insolvent. At the end of last year, even Vanke and Longfor, which have always operated relatively steadily, were hit by the market, which shows that the crisis of developers this time is very serious.

The developer defaults on a large amount of supplier payments, putting a large number of financial institutions and even natural persons' funds at risk, and the financial risk cannot be underestimated.

At the same time, due to the decline in housing prices and land prices, and the troubles of developers themselves, the enthusiasm of developers to buy land has dropped sharply, and the income that local governments can receive from land has also fallen sharply.

Since much of the financing of local governments and developers is secured by land, the balance sheets of financial institutions are also under considerable threat, as is the case with the recent explosion of Zhongzhi Group.

In addition, the decline in housing prices has also put pressure on residents' consumption through the wealth effect. In the past, when house prices were rising, buyers felt that their net worth was increasing, so they were more inclined to spend than save.

Now that the myth that house prices only go up and not down has been shattered, buyers have begun to accumulate savings for the uncertain economic situation, and even prepaid their loans, which has limited the spending propensity and spending power of buyers.

Now the real estate industry is in crisis, which poses a huge risk to the Chinese economy.

To deal with such risks, we need an institution with enormous resources, and only the central bank, the People's Bank of China, meets this condition.

The central bank's greatest advantage is its money-creating power, which means that as long as it does not trigger inflation, then the central bank can create a steady stream of liquidity to save the entire economy.

If there is a problem with a real estate company or financial company with systemic risk in the future, then the central bank's intervention will be crucial.

In this regard, we can refer to the Fed's direct intervention in Silicon Valley Bank in March 2023, when the Fed's intervention effectively prevented the spread of SVB's risks.

03

Solve the end demand

Compared with some developing countries, China has a large economy, complete industries, developed import and export business, and sufficient room for maneuver, so it has a high risk prevention ability, but if we want to continue to maintain a rapid economic growth rate, then we need a series of structural reform measures.

Structural reform is aimed at structural problems, so what are China's structural problems?

There are many structural problems in China, but the core and most critical of them is that the consumption rate of residents is too low.

Household consumption is so low that we have to rely on domestic investment and foreign consumer demand to absorb our production capacity, but now China's real estate is in the doldrums and the marginal returns on infrastructure investment are diminishing.

In addition, under the influence of geopolitical and other factors, foreign trade has also encountered difficulties. It can be said that the economic growth model we relied on in the past is no longer sustainable.

In fact, the proposal to increase the consumption rate has been talked about for at least 20 years, and although we knew that it was an inevitable reform, we have always lacked the determination to push forward with this reform.

Now is the time to wait, and China's economy can only enjoy the high-quality growth brought about by turning to household consumption.

So how can we stimulate residents' consumption demand?

The author believes that in order to break the current deadlock, there are at least two measures that can be taken:

First, reduce the social cost of regulation and increase the disposable income of residents.

There are many suggestions for increasing residents' incomes, but I believe that one that is often overlooked is to reduce the cost of regulatory compliance borne by the whole society.

Regulation is necessary in many areas, but regulation itself comes at a cost, which is generally reflected in companies scaling back investment and hiring in order to meet compliance requirements, consumers spending less in the face of higher prices for products and services, and so on.

Therefore, it is important to reduce the social cost of regulation. Taking pollution control as an example, we can force all enterprises to reduce pollution, or we can build a market for trading emission rights. Both economic theory and practice have proven that trading emissions is a cheaper solution to pollution.

On the premise of achieving regulatory objectives, the lower the cost of regulation, the less negative impact regulation will have on economic activities including investment, recruitment, production, logistics and consumption, so that people will have more and better employment opportunities, earn more disposable income, and be able to buy the consumer goods they need at lower prices.

Second, we need to consolidate social security, especially medical insurance, to effectively reduce the precautionary savings that residents have prepared to pay for medical expenses that may occur in the future, and use more disposable income for consumption.

On the issue of medical insurance, the author believes that there is one point that needs special attention, that is, adverse selection.

One of the things that is very taboo about insurance is adverse selection, which means that people who are sick are more willing to buy health insurance, while people who are not sick are not willing to buy health insurance.

If the insurance is taken on a voluntary basis, then medical insurance will become very expensive due to adverse selection, and it will even be difficult to maintain commercial operation. Compulsory medical insurance for all is an effective way to solve adverse selection.

The Government has an unyielding responsibility on this issue, and it must not hesitate in this regard.

Looking around the world, large economies are developing their economies with domestic demand, especially household consumption, as the core driving force, and China is no exception.

China now has the potential to use market-oriented methods to further improve the business environment, improve production efficiency, increase household income, and optimize the economic structure.

Under the joint reform of both supply and demand, we will first establish and then break, and gradually let the giant ship of China's economy turn around and sail towards a broader sea.

(End of full text)

This article was originally published on Caixin on January 8, 2024